Every business needs income in order to survive, and your business is no exception. But if you’re feeling the financial pinch, remember that you’re not alone, and that a cash flow problem doesn’t necessarily mean that your company is destined for disaster. Maybe you need money for operational expenses like payroll or supplies that will eventually contribute more value and income to the company. Perhaps you’re in a cyclical business and you need to cover expenses during the slow season. Or maybe you just want to know that you’ve got cash waiting in case you have unforeseen expenses in the future. A small business line of credit can help you take control of your company’s finances while providing several significant benefits to your business which will be discussed later in this guide.
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Can a Small Business Line of Credit Help Your Business?
What is a Small Business Line of Credit?
A small business line of credit is a way for small businesses or startups to gain access to money that can be used for managing cash flow, financing day to day operations or pursuing new opportunities that require cash above the company’s set budget. A small business line of credit (sometimes referred to as a corporate line of credit) can provide a company with an emergency fund to cover any expenses as needed. Once approved, the line of credit is available to the business owner (or CFO), but the repayment (with associated fees) is done only on the borrowed amount. If the credit isn’t used, it sits there patiently waiting for the day if/when it is needed. Lines of credit are usually extended for a defined amount of time such as one or two years.
Our Loan Review Process
A small business lender is the entity that will fund your loan. If you’re taking out a private small business loan, the lender may be one of dozens of private lenders. If you take out an SBA loan, the lender will be a bank or non-profit that will be backed by the Small Business Administration. Of course, you may be lucky enough to get a small business loan from your bank, but most financial institutions prefer not to grant small business loans, which is why private small business loans have become so popular. It’s worth noting that if for any reason you are unable to secure a loan from more traditional lenders you can look into peer-to-peer lending opportunities.
To help you make the right decision, we’ve reviewed dozens of small business lenders, and weighed factors that will be most important during the decision-making process. We started by listing the requirements that each lender demands in order to approve your application. This will give you a bird’s-eye view of whether a specific lender is a good fit for your business. Then we researched the types of loans offered, loan rates and fees, maximum loan available, and rates and fees for each lender. We’ve also evaluated the ease of the application process, the time it takes to process the application, and the customer service offered by each small business lender. Finally, we’ve read hundreds (if not thousands!) of reviews left by real users to see what others are saying about each lender. Sure, our professional opinions are important – but why trust us alone, when you can get a cross-section of user reviews without having to spend the time reading them all? We’ve done the work for you so that you can spend more time focusing on your business and less time focusing on your business loan.
Let’s take a practical example: Let’s say you are the owner of a catering company. Your company has a $10,000 line of credit. During the holiday season you will be catering extra holiday parties, for which you need to purchase the raw food in advance. You also need to rent an extra truck to transport all of the products to the right place. You use $5,000 to make your purchases and to pay the truck rental fees. You now have $5,000 remaining on your line of credit to be used if needed, such as if you get another job that requires additional outlay or your freezer suddenly breaks down. When the holiday season is over, you repay the debt (principle plus interest) on the borrowed $5,000 and you once again have $10,000 to borrow if another need arises. In other words, a line of credit is akin to a financial safety net; you hope you’ll never need it, but it’s a relief to know it’s there if necessary.
How to Qualify for a Small Business Line of Credit
The qualification requirements for a small business line of credit vary by lender. Some lenders, such as OnDeck, require at least one year in business and a majority owner of the company with a personal credit score of 600 or higher. Other lenders, such as Fundbox, require a company to have been in business for only three months, and have lower credit score requirements as well. You can do a quick check of the requirements of our top recommended line of credit lenders in the chart above, but you should read the fine print before applying for any line of credit to make sure that your company will be eligible.
A brief word about credit scores: a great personal credit score is anything between 740 and 800. A very good score is between 670 and 739. A fair credit score is between 580 and 669. Anything lower than 580 is likely to be considered a bad personal credit score and may impact your chances of getting approved for a line of credit by some lenders.
Business credit scores are based on a different scale, one that goes from 0 to 100. Calculating your business credit score can be done by one of the three primary companies in the United States – Dun & Bradstreet, Equifax or Experian. Each company’s credit report is based on slightly different criteria, so make sure to do your homework before choosing a reporting agency. For example, Dun & Bradstreet credit scores are heavily based on a company’s payment history, while Experian looks at a multitude of other factors including credit information from the company’s suppliers, legal filings from local courthouses and public records relating to the company including liens or judgments against the company. Experian also looks at your outstanding debts and the size and age of your business.
Keep in mind that requesting your business credit score may impact your score, so don’t request it unless you’re sure you need it. It will also cost money, so make sure to factor this into your calculations when assessing the cost of the credit line.
As part of the due diligence process, lenders may ask you about the following:
– Collateral – does your company have any assets that can be used to pay back the loan if necessary? Assets can include real estate, machinery, inventory and even accounts receivable. In some cases, a company may be required to commit all of its assets as collateral in order to secure a line of credit.
– Revenue – In order to qualify for a line of credit you’ll likely have to prove that you have a minimum amount of monthly/yearly revenue and that the company is profitable. If you don’t have revenue or profit the likelihood will be higher that you’ll need substantial collateral in order to qualify for a loan.
– Guarantors – Most lenders require a corporate guarantee which is a promise that the parent company will repay the loan if necessary. In addition, some lenders also require the company’s founder or other executives to guarantee the loan.
– Financial Calculations – Does your company have too much debt compared to its equity? Does your company generally pay its debts and expenses in full and on time? Does your company generally have enough cash to manage its obligations?
– Personal credit scores of company owners – It’s quite common for lenders to check the credit of a company’s owner/s before agreeing to lend his or her company money. They want to get an idea of whether or not you have a solid understanding of how to manage finances or whether possible cash flow problems in your company could hint towards more systemic problems with money management. If you have a good credit score you should have nothing to worry about, and if you don’t, there’s never been a better time to get your personal finances sorted – it’ll be a positive step for both you and your business.
Before applying for any business line of credit, make sure to familiarize yourself with each lender’s requirements. You should also pay extra attention to the paperwork you’re submitting for each application to make sure that it’s neat, orderly and presents your company in the best possible way. A few minutes of research and preparation time will save you time and frustration throughout the process.
Types of Lines of Credit
As is the case with small business loans, there are many types of small business lines of credit. We recommend familiarizing yourself with your options as a starting point in order to determine if a line of credit is the best funding option for your business, and if so, which type of line of credit is the best one for you.
Secured Vs. Unsecured Lines of Credit
A secured line of credit is one in which the borrower offers collateral as a security deposit to confirm the line of credit. As mentioned previously, the collateral could be company equipment, inventory or real estate, among other assets. Lenders usually prefer secured lines of credit because it is less risky for them, as they know they have assets to repay the loan if needed. Borrowers often prefer secured lines of credit (if they have ample collateral) because they enable lenders to provide lower interest rates and higher credit limits because the loan is guaranteed.
Unsecured lines of credit are those that do not require collateral. These loans are more suited to companies that don’t have collateral they can offer to secure the loan. The interest rates tend to be higher than those of secured lines of credit because the lenders are assuming a higher level of risk. Still, depending on your company’s circumstances, an unsecured line of credit may be a better option than a standard small business loan because it provides additional flexibility and less risk for the company.
Revolving Vs. Fixed Line of Credit
A revolving line of credit is much like an open-ended loan – the business owner can borrow as much or as little money as he wants within the pre-approved limit, without having to reapply each time he wants to borrow money. Once the borrowed sum is paid back, the line of credit expands again so that the business owner can borrow the money again if needed, within the term of the line of credit. A fixed line of credit allows business owners to borrow money only one time. If they want to borrow more money they must reapply, even if they’ve already paid back the original loan.
Small Business Line of Credit Fees
The fees related to small business lines of credit vary depending on the lender and the terms of the credit line. That being said, there are certain fees that you should look for before choosing a lender. You should also consider the repayment terms of the line of credit; in most cases, if you repay the credit faster, the interest will be lower. If you have a longer repayment term, the interest will be higher. Think about what payment your company can afford and choose the right term accordingly. If you’re not sure which option is best for your business, most of our top recommended lenders have counselors that can help you make this critical business decision.
Application/Origination Fees: Some lenders charge application fees or origination fees for their lending services, but at the time of this writing, none of our top lenders charged application fees for a small business line of credit.
Credit Report Fees: As mentioned earlier, requesting a credit report for your company will cost money. The fee (hopefully) won’t break your bank, but since you have options, it’s good to know what they are. An Experian business credit score can cost as low as $39.95 while an Equifax report will cost approximately $100. The Dun & Bradstreet business credit report costs $61.99.
Monthly Fees: Some lenders charge a monthly fee. For example, OnDeck charges a $20 monthly fee which is waived for six months if the business owner withdraws $5000 or more within 5 days of opening the line of credit. Most lenders, however, will offer a small business line of credit without a monthly fee.
Miscellaneous Fees: There are some other small fees that a borrower should be aware which may be small, but can really add up, especially if you’re concerned about your bottom line. For example, BlueVine charges $15 for every wire transfer. LoanBuilder charges $20 for insufficient funds. This type of modest service fee varies from lender to lender, which is why it’s important to read the fine print before committing to funding from any lender.
Prepayment Penalties: Most of our top recommended line of credit lenders do not charge a prepayment penalty. However, it should be understood that when repaying the balance of your line of credit, in most cases you’ll be required to pay the full interest amount charged for the entire loan term, even if you pay early. Some lenders, such as OnDeck, may even offer a discount if the credit line is repaid early.
Interest Rates: This is where you’ll find the biggest variance between lenders – and where you’ll need to take the most research time to make sure you’re getting the best possible rates and terms. Interest rates for small business line of credits can be calculated on a weekly basis, a monthly basis or an annual basis. Likewise, most line of credit lenders will require payment either on a weekly or monthly basis. As a first step in your decision-making process, think about which payment term will work best with your business cycle. You can compare the interest rates of our top small business line of credit lenders in the chart above.
Is a Line of Credit Right for Your Business?
You probably asked yourself this question 100 times before reading this article, but now that you know more about how small business lines of credit work, it’s time to ask yourself this vital question one more time. There are many different types of funding available for small businesses, including merchant cash advances, small business loans (both long-term and short-term loans) and invoice factoring services. A line of credit can be a great option because it offers much more flexibility than many of the other options, but that doesn’t mean it’s the best option for your specific business. Consider the following to determine if a small business line of credit is right for your business at this time.
Advantages of a Small Business Line of Credit
A line of credit can offer many benefits to your company, especially if used responsibly. Realistically speaking, you likely only need one of these benefits to be relevant to you in order to make a line of credit the right choice for your business. That being said, it’s a good idea to understand all of the benefits of a line of credit so that you’ll feel confident and comfortable with your eventual decision.
1 – Quick access to funds. One of the biggest benefits of a line of credit is that you can apply for the funding before you need. In other words, you can do the research and identify the best options when you have time and aren’t stressed about finances and making payments. Then, if/when you need the money, your line of credit will be instantly available to fund whatever you need. Unlike traditional loans that you borrow in one lump sum and must repay regularly, a line of credit just sits there until you need it, so you’re not (usually) paying for the privilege of having this cash available to you.
2 – Flexible payment terms. Most traditional small business loans require a set monthly repayment amount. A significant advantage of a line of credit is that it functions similarly to a credit card; if you can’t make the full payment one month for whatever reason, you can make the minimum payment without defaulting on your loan. Then, when you have more money available, you can repay the rest of the loan.
4 – Build solid business credit. If you have little business credit or possibly even bad credit, a business line of credit can help you establish a better credit score. That is, assuming you pay the payments on time. If you establish a pattern of repaying your line of credit fees, you’ll build a good credit score that can help you get approved for future funding if the need arises.
5 – You can get an unsecured line of credit. As mentioned previously, unsecured lines of credit tend to have higher interest rates than secured lines of credit, but they offer one significant advantage; your company is at less of a risk if you default on your payments. With a secured credit line, if you miss payments the lender can seize your assets. With an unsecured line of credit, the lender has less recourse in the event of a default, which means your assets are safer. Of course, it should be noted that you will need a very high credit score to get an unsecured line of credit, so this option isn’t relevant for every business. And of course, it’s a bad idea to default on your loan, even if your assets aren’t at risk.
6 – Lines of credit may have lower interest rates than loans. If you’re still unsure whether a small business line of credit is right for you, look at the bottom line. Can you get better repayment terms from the line of credit than from a small business loan? Many times, you can. This itself might make a line of credit a great option for your company.
Disadvantages of a Small Business Line of Credit
It may be hard to give full weight to the disadvantages of a small business line of credit once you’ve become enamored with the benefits of this funding type. That being said, it’s extremely important that you go into the borrowing process with your eyes wide open about the potential pitfalls and dangers you may encounter. While these disadvantages may not be relevant to every borrower, you should think carefully about whether they will apply to you and your business.
1 – Propensity for misuse. The allure of a revolving line of credit is undeniable. Easy access to cash, low interest rates, for any use – what could be bad? The truth is, sometimes when things look too good to be true, they might be just that. A business line of credit can be incredibly valuable. But if it’s used irresponsibly, it can ruin a company’s credit, create a spiral of financial trouble, and possibly even lead to the seizure of the company’s assets. For these reasons alone, we recommend using a business line of credit with caution. Withdraw money only for a specific, justified purpose, and only if there’s no other way to fund the endeavor – this should protect you from misusing the line of credit and ruining your company’s credit.
2 – Lower funding amount than small business loans. Small business lines of credit are great for things like covering cash flow problems or paying for certain business purchases. However, many lines of credit are available for only up to $100,000, $250,000 or even $500,000. If you’re looking to make a significant purchase, a line of credit may not be enough to cover your needs.
3 – Complex application process. Getting the funding from a business line of credit may be easy once you’re approved, but the application process is known for being extremely complex and for requiring more paperwork than many traditional small business loans. You may also be subject to an annual review to confirm that you’re still eligible for the line of credit.
4 – Possibility of a sudden cancellation. Unlike a loan in which you get the money up front, you’re unlikely to withdraw your entire line of credit at once. A lender has the right to restrict access to a line of credit if the borrower misses payments for any reason or if the company’s revenue shows significant declines. For this reason, it’s important for every business owner to be conscious of the amount of credit used at any given time and to protect himself accordingly.
Business Line of Credit Vs. Business Credit Card – Is There a Difference?
There’s no question that a credit card and a business line of credit work in similar ways, but it’s the differences between them that will really help you determine which type of credit is best for your business. Most people are familiar with credit cards; they have a maximum credit limit and offer revolving credit as long as the money is paid back on time. Credit cards are unsecured, so they don’t require collateral to get the credit. This makes them similar to an unsecured line of credit. However, credit cards tend to have a higher interest rate than a line of credit (even an unsecured line of credit which has a higher interest rate than a secured line of credit). Perhaps the biggest difference between a credit card and a line of credit, however, is that a line of credit can be used for cash advances, such that if necessary, business owners can withdraw the entire amount of the line of credit if needed. Credit cards tend to be much more restrictive in this regard; most credit cards let you withdraw only up to 20 percent of your credit limit as a cash advance.
On the other hand, there are some benefits to credit cards that lines of credit can’t provide. For example, many credit cards off rewards perks – cash back, mileage, and even signing bonuses that can be helpful for the business or the business owner. Likewise, credit cards tend to have shorter application fees and easier acceptance processes than business lines of credit, which can be an advantage (still, we wouldn’t recommend choosing a funding type only because the application process is easier!).
Business Lines of Credit for Bad Credit
If you are concerned that your business has a bad credit score, you’re not alone. Not only are there many businesses out there that have less-than-ideal credit scores, but there are also many businesses that don’t have any credit score to speak of, either because they are too new and haven’t built up their credit yet or they haven’t been able to make payments on time for one of any number of reasons.
The good news is that the personal credit history of the business owner can help your company qualify for a business line of credit. The bad news is that if your personal credit history is spotty, you may still have a problem getting approved. And yet, there still may be ways to get the funding you need.
Some of our top recommended lenders such as Kabbage and Fundbox offer lines of credit to businesses that wouldn’t qualify elsewhere. Fundbox has no minimum personal credit score for business owners seeking lines of credit. They do, however, require at least three months in business and a minimum income of $50,000/year. Kabbage requires a minimum personal credit score of only 560, while many lenders require the company owner to have a credit score of at least 600.
If neither of these are good options for you, we recommend trying to fix your line of credit in order to qualify. This will not only help you get your business in better financial health but will enable you to secure better terms for your line of credit. One way to do this is to work with a business coach or CPA who can look at your expense sheets and make practical recommendations for how to improve your bottom line. You can also try to apply for a business credit card that, if approved, can provide you with funding while helping to improve your credit score if you pay on time. Just remember that improving your credit score won’t happen in a day or even a week – it can take months to see a significant difference in your credit score (one that will impress lenders).
Finally, it’s important not to get discouraged – many lenders are happy to provide advice and guidance and may even be able to refer you to a different lender that can help. This advice is easier said than done but can make the difference between getting funded or getting stuck. Alexander Graham Bell, noted scientist, inventor and entrepreneur, famously said that “when one door closes, another opens.” If you keep this mantra in mind when looking for funding, you may be pleasantly surprised by the results.
According to research published by CB Insights, 29 percent of startups fail because they run out of funds. Unfortunately, however, this phenomenon is not one that only plagues startups. Many established, seemingly successful companies face cash flow problems, financial mismanagement and other economic setbacks, even after raising or earning millions of dollars. Among the well-known companies that filed for Chapter 11 bankruptcy protection in 2018 alone are shoemaker Nine West, accessories giant Claire’s, and Sears. Toy retailer Toys R’ Us shuttered its doors completely after failing to restructure the company by filing for bankruptcy. These stories aren’t just cautionary tales – they’re lessons about the importance of fiscal responsibility that must be taken seriously by small and big business owners alike.
A line of credit can be a great tool for keeping a small to medium-sized business afloat during difficult times, slow seasons or in the face of unexpected expenses, among other challenges. However, it is extremely important to realize that this privilege is one that should be used responsibly, for specific purposes. At no time should a line of credit be used by business owners simply because it is available. It shouldn’t be used for frivolous expenses or to ‘hide’ bigger financial issues that can cause problems for the company.
You’ve started a company, a huge accomplishment in its own right, and you should be proud – and willing to do whatever it takes to get your business on solid financial ground. A small business line of credit may be just what you need to build your peace of mind as you build your small business into a larger one.